Global economic outlook: February 2023

The shocks that buffeted the global economy in 2022 and sent global inflation to a near three-decade high above 9% should dissipate in the year ahead. Inflation in the US, euro zone and the UK has already fallen from peaks of around 10% in the second half of last year and should continue to decline steadily in the months ahead. But how quickly it falls will depend in part on the relative importance of supply and demand factors that have driven prices higher over the past two years.

The US economy has most clearly been facing a situation of excess demand and an extremely tight labour market, with more job vacancies than unemployed workers to fill them. Wage growth remains higher than is consistent with the Fed’s inflation target, but it has slowed enough to allow the Fed to shift down a gear at its February meeting, when it announced a 25 basis points (bps) hike (versus 50bps at previous meetings). Further hikes are likely in March and May, before the Fed pauses to take stock.

By contrast there have been fewer obvious signs of excess demand in continental Europe, where the main driver of inflation was the substantial energy supply shock following Russia’s invasion of Ukraine. Although European wholesale energy prices have fallen sharply in recent months, prices are still double the level they were a couple of years ago and this step-up will feed through to business costs (and prices) with a lag. This has been noted by the European Central Bank, which is still eyeing a further 50bps increase in its policy rate in March, with a further hike possible in May.

Meanwhile, the UK faces both challenges—surging energy costs and an extremely tight labour market—which has kept inflation higher than in its peers and created one the most challenging macroeconomic backdrops amongst advanced economies.

While central banks are not yet ready to declare victory over inflation, the focus for policymakers is likely to turn to growth in the coming months. Global activity slowed late last year in response to the sharp tightening of financial conditions in major economies. Encouragingly, recent economic data has surprised to the upside, suggesting greater resilience than sentiment indicators had suggested late last year. And there are signs that confidence is now improving.

There are two obvious factors driving the brighter outlook for this year: the dramatic improvements in Europe’s energy supply situation in recent months and the re-opening of China’s economy, which is already showing signs of recovering following the lifting of pandemic restrictions late last year. The euro zone now looks likely to avoid a recession early in 2023, and there is a lively debate over whether the US could also achieve a “soft landing”.

But although there are more reasons to be cheerful, we still believe that global activity will remain fairly subdued in the near-term, as household incomes continue to be squeezed by high inflation and the full effects of last year's aggressive policy tightening feed through to housing market activity, consumer borrowing and investment.